What Are the 5 Most Common Retirement Plans to Help Me Retire?
Everyone knows that saving for retirement is crucial for ensuring a healthy financial future, but most people make serious planning mistakes that can undermine their ability to accumulate wealth.
One of the most important decisions that you will have to make is regarding the type of retirement account that you will use. The tax code offers several tax-advantaged accounts that each offer a broadly different range of advantages and disadvantages. You can take the first step toward an enjoyable retirement by taking the time to understand what retirement account is right for you.
401(k)s are the most common form of retirement account because employers can easily set them up without requiring you to do any paperwork. By default, most 401(k) accounts that are created by employers are transferred into a mutual fund managed by investment professionals. However, as with all retirement plans, you can roll over the 401(k) created by your employer into a brokerage account that you control. You can, then, use the funds to buy stocks, bonds, or even real estate.
Advantages of 401(k)s
- Money is invested on a pre-tax basis, so you can defer taxation until retirement.
- You can contribute up to $19,000 per year into your account.
- Employers commonly offer 401(k) match programs that can double your retirement savings up to a limit determined by your employer.
Disadvantages of 401(k)s
- Minimum distribution laws can require avid savers to withdraw substantial amounts of money each year during retirement, which can lead to a higher income tax rate.
- Although you can exercise substantial control over how your assets are managed, 401(k) plans offer less flexibility than IRA or taxable accounts.
- The logistics of rolling over 401(k) funds into an account that you control can be complex.
Traditional IRA Accounts
Traditional IRAs are the easiest retirement accounts to set up for most people. You can set up a traditional IRA using your own funds if your employer does not offer a retirement plan. When you set up your own account, you get maximum control over your own assets.
Traditional IRAs also offer the broadest range of investment options, so they are often seen as a good choice for people who aim to become self-employed in the future.
Advantages of Traditional IRA Accounts
- You can immediately deduct contributions made to a traditional IRA on your federal and state tax returns.
- Full deductions can be claimed for single individuals making up to $64,000 per year. For married individuals whose spouse does not work, full deductions can be claimed if your income does not exceed $193,000.
- You can withdraw up to $10,000 from your account under the age of 59 and a half without incurring a penalty.
Disadvantages of Traditional IRA Accounts
- You can only contribute what the IRS qualifies as “earned income” into a traditional IRA.
- You must be under 70 and a half years old to make contributions into your account.
- As of 2019, annual IRA contributions are limited to just $7,000 per year.
Unlike with other retirement accounts, 403(b) plans are highly restricted. You can only make contributions to a 403(b) account if you work for a nonprofit organization, a public school, or a hospital. The main advantage of 403(b) plans is that they are designed to function as annuities for retirement, so they provide steady returns for people who do not want to get involved in choosing their investments.
Advantages 403(b) Accounts
- 403(b) accounts are set up and managed by your employer, so you do not have to do anything to start saving for retirement.
- Taxes on contributions are deferred until retirement.
- You can contribute up to $19,000 into a 403(b) plan each year.
Disadvantages 403(b) Accounts
- Investment options are very limited with 403(b) plans.
- Since many annuities are illiquid, you may not be able to roll over your funds from a 403(b) plan into an account that you control.
- If you have a pension, you may incur higher taxes because you will have to report withdrawals from both your pension and 403(b) account to the IRS.
Simple IRA Accounts
A Savings Incentive Match Plan for Employees gives advantages that are similar to a traditional IRA. Simple IRAs are different, however, because they are designed for self-employed individuals and small business owners. Only employers with less than 100 employees can set up a Simple IRA plan, so you cannot establish one of these plans on your own if you work for someone else. In general, Simple IRA accounts are seen as more advantageous than other IRA options when they are offered because they legally require employers to match contributions.
Advantages Simple IRA Accounts
- Your employer is required to match contributions equivalent to at least three percent of your salary.
- Even if you contribute nothing to your account, your employer is still required to contribute at least two percent to your Simple IRA plan.
- Unlike with other IRA accounts that have low limits, you can contribute up to $13,000 into a Simple IRA account each year.
Disadvantages Simple IRA Accounts
- You cannot set up a Simple IRA on your own unless you are self-employed.
- If you make a withdrawal less than two years after funds are deposited into your account, the IRS can hit you with a 25 percent penalty.
- You cannot make any loans to yourself using a Simple IRA account.
Roth IRA Accounts
Roth IRAs are retirement accounts that let you withdraw your money at any time without incurring any penalties. Therefore, if you aim to retire early, a Roth IRA might be the best option for you. You can also use a Roth IRA as an investment vehicle in retirement since these accounts are not subject to the minimum distribution rules that apply to other retirement plans. Overall, Roth IRAs are the best option if you demand maximum flexibility.
Advantages Roth IRA
- The ability to hold money in a Roth IRA throughout retirement makes these accounts ideal for estate planning.
- Withdrawals can generally be taken from Roth IRA accounts without having to pay any taxes.
- Since Roth IRA contributions are taxed only in the year in which they are earned, you may be able to reduce your overall tax liability if you plan to accumulate substantial wealth.
Disadvantages Roth IRA
- Contributions made to a Roth IRA account are not deductible.
- Although you can make contributions during retirement, these contributions are subject to a $6,500 limit.
- Roth IRAs must be set up without the assistance of your employer.